Rental Portfolio Profitability Master Class Underwritten by RMB Structured Insurance Limited...
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Rental Portfolio Profitability Master Class Underwritten by RMB Structured Insurance Limited Practical strategies for profitable portfolio’s 7 – 22 September 2014 An authorised financial services provider – FSP 43441
Rental Portfolio Profitability Master Class Underwritten by RMB Structured Insurance Limited Practical strategies for profitable portfolio’s 7 – 22 September
Rental Portfolio Profitability Master Class Underwritten by RMB
Structured Insurance Limited Practical strategies for profitable
portfolios 7 22 September 2014 An authorised financial services
provider FSP 43441
Slide 2
First, a note on CPD points 60 points need to be earned in a 3
year cycle (20 points per year) Points are split into 2 categories,
namely verified and non-verified Currently the EAAB is the only
body allowed to provide verified training Non-verified training has
to conform to time and content requirements (duration &
relevancy) Verified (45 points) 3 Year Cycle (60 points) Education
and training Non-verified (25 points) Professional development (max
5) Corporate Social Investment (max 5) Mentoring and coaching (max
5) Reading and publishing (max 5) Personal development (max 5)
Slide 3
And then a word on who we are 5 5
Slide 4
Our agenda for this morning An authorised financial services
provider FSP 43441
Slide 5
The next few hours 09:00 09:30PayProp State of the Rental
Industry update 09:30 10:30The rental portfolio business model
10:30 11:00Tea Break 11:00 12:00Valuation of a rental book 12:00
12:30New in the industry 12:30 12:45Summary & Closing
Slide 6
The State of the Rental Industry Q2 2014 An authorised
financial services provider FSP 43441
Slide 7
Our predictions for the remainder of 2014 1.Average rental
growth will settle in the 8% - 10% range 2.Consumer payment data
will continue to deteriorate 3.Damage deposits will become
un-affordable to tenants and deposit replacement products will
become more commonplace 4.Property investors will not see net
yields of above 6% for some time 5.Watch the Northern Cape!
Slide 8
Average rentals break the R6 000 barrier Current weighted
average rental in South Africa is R6 144
Slide 9
Growth has stabilised Growth rates are slowing down after
having hit a high of 10.8% in October 2013 Current year-on-year
growth rate is 8.9% and we expect it to stay there for some
time
Slide 10
Limpopo normalises Limpopo is starting to slow down Mpumalanga
continues with stable growth Eastern Cape has an impressive
recovery Northern Cape is the new emerging start Freestate
continues to struggle Western Cape, KZN and Gauteng continue to
experience stable growth Very little movement in the North
West
Slide 11
Damage deposit ratios stabilise Stabilisation in damage deposit
ratio Currently at 1.34 It seems that there is a limit to what
tenants can afford Growth of deposit replacement products
Slide 12
Low, but stable investor returns Both net and gross yields
remain stable despite rental growth Consummate increase in property
values neutralise gross yield gains Consummate increase in cost of
ownership neutralises net yield gains Remember that the yield
calculation does not take capital growth into account if that is
added in, it increases to 12.81% Rental yields therefore only cover
the cost of ownership and investment opportunity costs
Slide 13
Counter-intuitive provinces lead the pack Northern Cape,
Limpopo and Mpumalanga offer the best returns for investors High
cost of ownership in the Western Cape and Gauteng limit what
investors are able to take home
Slide 14
Agents defend their commissions Agents seem to have taken a
deliberate decision to defend their commissions There was a time
that the data showed a declining trend, similar to that of sales
commissions However, we are increasingly hearing of non-metro
commissions being under increasing pressure
Slide 15
Our first lesson on profitability You will only do well, if
your landlord does well Current national average cost of ownership
sits at 33% and is increasing Agent commissions Rates & taxes
Repairs That means that on an average rental of R6 144, a owner
only takes home R4 116 There is little room for error in making
sure that your landlord is happy
Slide 16
The rental business model An authorised financial services
provider FSP 43441
Slide 17
Basic assumptions We built the model based on a set of
assumptions developed through our exposure to hundreds of rental
portfolios The model is meant to help test some of the most
important assumptions the owner of a rental business faces It is
not meant to provide definitive answers, but to help you stress
test different scenarios for your business A model like this should
not be viewed as investment advice, but merely one of a series of
tools that you could use to better understand a business We will
e-mail all attendees the model tomorrow You cannot break it so feel
free to play with it However, you also cannot edit detailed
assumptions
Slide 18
Lets define average This is the typical rental portfolio that
we come across (and that we have used for modelling) 100 properties
with 10% managed commission No real introduction rentals 98%
collections each month 1 Admin and 1 agent Admin on fixed R7 500
and agent on 50% commission split Charging lease fees, and little
else Results-wise, this agency produces R60 211 in commission each
month Retains R31 473 as profit (48%) That is R3 800 profit per
property per year
Slide 19
The first, most basic income principle Tenants vs paying
tenants According to the latest TPN report 6% of tenants are not
paying rent You can legally only take your commission once the rent
is received so without rent you have no commission On a typical
portfolio, you make an additional R350 net profit for each
percentage point in collection improvement The difference between
the industry norm of 94% and the 100% collection is just over R25
000 per year This does not begin to include the cost, time and
effort of dealing with a non-paying tenant How to increase
collections Better tenant selection Early detection Credible threat
Rental/deposit guarantee products
Slide 20
And what if they dont pay? Debt collection fees There are
legislated fees up to a maximum of R841 R17 per fax, email, phone
call, letter, necessary expenses R2.20 per SMS R166 for serving
physical documents R33 for drawing up settlement accounts R41 per
consultation R8 for correspondence received You can only charge
these fees if you are a registered debt collector Late payment
penalties Some leases make provision for the use of a late payment
penalty if the tenant does not pay Take note that this is
interpreted differently in different provinces in Gauteng it is
illegal and in the Western Cape it is not Understand why you are
charging this fee (and explain it accordingly) Is it to compensate
you for reasonable costs of collection? Is it to compensate the
owner for lost interest Do not confuse why you are collecting with
who you are collecting for!
Slide 21
Other income variables to consider Transaction fees and tenant
admin fees Tenants have a number of payment channel choices, some
which are cheaper than others Depending on the conditions of your
lease, you may be able to recover some of these costs Dont limit
your options by only stating cash deposit fees as this is an area
of growing diversity (rather use transaction fees as a descriptor)
Banking Fee ComparisonAverage Account Fee R 51.88 EFT's R 7.60
Debit Orders R 8.60 SMS's R 0.79 Email's R 0.66 Fixed Cash Deposit
R 6.78 Cash Deposit %1.22% Sources of incoming funds Average
transaction charges
Slide 22
Recovering transaction fees Just recovering cash deposit fees
equates R873 per month in additional net income for your business
However, per tenant recovery can be cumbersome and some agencies
are resorting to a fixed tenant admin fee that spreads total bank
fees across the entire tenant pool As long as it is in the lease
and the tenant explicitly agrees to the cost, either route is
feasible
Slide 23
Some income variables to consider Credit check fee Credit check
costs can vary from R68 R138 per check In many cases it takes up to
5 checks to find an appropriate tenant, and you are bearing the
cost of this each time With the escalation in these fees, many
agencies are asking an up front application fee In a typical
agency, a R100 per check recovery adds R10 800 per year to the
bottom line Refunding successful tenants drops this saving to R7
200 Lease fee Traditionally charged because lawyers were used to
set up legal agreements, but the availability of specialised (and
free) contracts has reduced the need to do this Accordingly this is
pure profit and at around R750 a time adds almost R4 500 to the
profit pool On introduction rentals the result is even greater
However, section (p) was added into the Rental Housing Amendment
Act in 2008 any costs in relation to contract of lease shall only
be payable by the tenant upon proof of factual expenditure by the
landlord
Slide 24
Some income variables to consider Damage deposit management fee
The Estate Agency Affairs Act and EEAB guidelines state that you
can keep the interest on a deposit only if you have clearly
informed the tenant of the interest and your intention to keep it
If you retain interest, you have to pay 50% over to the EAAB
However, the law does not prohibit you from charging an
administrative fee for managing the deposit Your fee is justifiable
as you incur transaction, service, audit and direct administrative
costs in keeping the money Administrative fees dont have to be
shared the same way as interest retained In determining what is a
feasible charge, consider the interest that an average deposit
earns The average damage deposit is R7 930 (1.3 x rental) 5%
interest rate earns it R371 per year in interest 1% interest rate
earns it R75 per year in interest It would be grossly unfair to the
tenant (and the landlord) to charge more than the interest earned
Checking the boxes Remember that you cannot levy any charges that
are not explicitly agreed to in the lease Be upfront with landlord
on additional charges you levy Ensure that you provide a
post-payout breakdown of all deductions
Slide 25
Procurement vs managed rentals Typically procurement rentals
attract a lower commission (7.5%) Interestingly, not really
dissimilar from a margin % perspective However, on actual cash
contribution to the business, managed rentals deliver double the
income Managed rentals Monthly income per property R 614 Monthy
expenses per property R 374 Annual once-off income per property R
750 Annual once-off expenses per property R 135 Total profit per
property per year R 3 497 Net Margin %43% Procurement rentals
Income per property R 3 686 Expenses per property R 2 088 Total
profit per proptery per year R 1 599 Net Margin %43% Other reasons
why we believe that managed rentals are a smarter option You stay
closer to the owner and more likely to get the renewal You are
closer to being the effective cause of a sale
Slide 26
And this is what the sandbox looks like In the model we have
provided you with an Income Variables play-space where you can
adjust the different variables to see what effect it is likely to
have on your income By just adjusting some of the basic variables
(transaction fee recovery, lease admin fee, credit check fee), we
were able to show R3 500 pm more in profit Thats more than R40 000
per year
Slide 27
Some expense variables to consider Manual vs automation When
starting a portfolio this is of minor concern the average manual
capability seems to be in the region of 50 properties Not investing
in automation is a self-limiting and expensive decision when you
are trying to grow
Slide 28
Some expense variables to consider Bank fees A rule of thumb is
that bank fees generally equate to 0.5% of turnover PayProp saves
you at least 30% on published bank rates Use batch-remittance fees
as far as possible Credit check costs Watch this space Accounting
You are required, by law, to reconcile your trust account every
month Time estimate is 1hr for every 25 properties Cost estimate is
between R350 R450 per hour Thats around R1 350 per month just to
reconcile a 75 property portfolios trust account Just having a
system does not absolve you from this responsibility
Slide 29
Employment structure considerations Basic role differentiation
Growth and maintenance Typically we find that without automation a
single administrator can manage 50-75 properties We find that
mostly there is a evolution of staffing in a typical agency, namely
me; me + part-time admin; me + full-time admin; full-time admin +
agent It is important to consider your growth horizon when you make
remuneration decisions early on, for example: Sharing commission
from day 1 when you have 5 properties, means that you will be
sharing commission when you have 100 properties The various means
to pay and their relative benefits Fixed salary Lease fee split
Managed lease commission Procurement lease commission The cost
associated with commission generation Bank costs System costs (i.e.
PayProp) and how to adjust for them
Slide 30
And this is what the sandbox looks like
Slide 31
Other issues to take into account Money is not only a means of
reward of services done, but is also a powerful motivator
Understand the type of behaviour that you would like to see in your
business, for example Motivating administrative staff on retention
of the existing book Motivating agents on constant flow of new
deals Some things to watch for Nest building Unintended behaviours
Reasonableness of income generated
Slide 32
Finally, a thought on growth Economies of scale work up to a
point, then your business settles at a stable margin % At below 50
properties, you are still absorbing a lot of fixed costs
Slide 33
Valuing a rental portfolio An authorised financial services
provider FSP 43441
Slide 34
Main schools of thought Net Present Value (NPV) Method The
basic principle: R1 today is worth more than R1 next year Cash
flows are projected forward, and discounted back to todays value
Risk factors are taken into account when determining a discount
factor You are paying for the current value of all future
cash-flows Earnings Multiple Method The basic principle: How many
months is it going to take for this business to pay for itself
Typically expressed in number of months that relate to net profit
earned I.e. 30 times earning multiple = 30 times average monthly
net income Practical Method A business is only worth as much as a
seller is prepared to pay for it
Slide 35
The same rules apply when using this model We built the model
based on a set of assumptions developed through our exposure to
hundreds of rental portfolios The model is meant to help test some
of the most important assumptions the owner of a rental business
faces It is not meant to provide definitive answers, but to help
you stress test different scenarios for your business A model like
this should not be viewed as investment advice, but merely one of a
series of tools that you could use to better understand a business
We will e-mail all attendees the model tomorrow You cannot break it
so feel free to play with it However, you also cannot edit detailed
assumptions
Slide 36
The most important variables to consider Investment horizon How
far are you prepared to look forward How far can you look back to
confirm the trend Realism of earnings assumptions How do I
interrogate the assumptions given (especially when they look
forward) Is the infrastructure in place to support the projections?
Assessment of risk what to look for Staff turnover Remuneration
package effects (look at all contracts) Landlord mandate losses
Deposit risk (is it all there?) Regulatory compliance Reputational
standing
Slide 37
Practical considerations What is the current financial status
of the business? Is there pending legal action? Are there major
debtors? Advertising the sale to potential creditors See section 34
of the Insolvency Act (1, 2 &3) What legal agreements are in
play? Are you legally allowed to buy this business? Are you an
estate agent? What is their standing with the EAAB? Grey area of
FFC renting
Slide 38
What am I buying? Two main considerations: 1.The legal entity
Risks You assume all debts and obligations Benefits Easy transition
2.The contracts of the entity Risks You have may loose a lot of
what you have bought Benefits You know nothing is going to come out
of the woodwork
Slide 39
Structuring the deal 1.Full cash-up front Once-off transaction
Clean split But what if worms come out of the woodwork. 2.Share
purchase with earn-out Buy a share now and I pay for the rest with
earnings from the business Give your share of the earnings each
month to buy back more shares until you own them all The better the
seller does in the transition, the quicker he gets his mone Risk:
loss of interest after having sold 3.Deposit + repayment plan Helps
if you dont have al the cash now Be prepared to pay slightly more
Consider the claw back 4.Escrow -based release plan Give all the
money to the lawyers Release on the achievement of key milestones
i.e. reconciliation of deposit account Meeting of budgeted
turnovers
Slide 40
So what are the general trends? With the regulatory compliance
burden growing, we have seen an increase in the rate of portfolio
acquisition Typically it is rare to take a view of more than 3
years on a rental book and most at a NPV level gravitate to a two
year view at medium to high risk This usually equates to around an
18 x monthly earnings multiple Interestingly, at these levels, the
valuation is not far of the rule of thumb of one months turnover We
have seen a few instances where, despite the valuation work being
very well done, that the deal structure turned everything into a
mess
Slide 41
New stuff! An authorised financial services provider FSP
43441
Slide 42
Weve summarised our previous learnings Go to the events page on
PayProp Select Rental Industry Session #4 Click on five things weve
learnt from the conference Enjoy
Slide 43
So we released some leases Thanks for the feedback Changes made
How to get them
Slide 44
And we are about to make you feel safer Beneficiary validation
available at the end of September 2014 Cost R3.80 per validation
Confirms identity and bank accounts match at the bank
Slide 45
And then you asked about tenant assessment Colin Habberton:
PayProp Capital: CEO
Slide 46
Understanding Tenant Risk In the May Masterclass we covered the
following points: What are the risks and how can they be mitigated?
Explain the importance of tenant assessment and some tools What to
look out for - contracting party vs. the tenant identity fraud The
purpose of using credit history in evaluating tenant risk The
requirement for consent - the relevance of the POPI Act Knowing how
to use credit reports the basics What can be buried in the detail -
number of accounts, recent checks How are these reports are
compiled - credit bureaux and the CPA Why tenants can be declined -
case study: DepositGuarantee rules
Slide 47
So what is our experience? DepositGuarantee On average between
60-70% of tenant applicants are ineligible Using a firm but fair
set of rules to assess total rental and indemnity exposure
Differences between our results and their current reports
affordability checks
Slide 48
How does that leave you feeling?
Slide 49
Introducing more than just a credit check
Slide 50
Assessment of Tenant Risk
Slide 51
Elements of the Report Identity Verification Fraud Check
Delinquency Report Credit Behaviour Indebtedness Affordability
Rental Risk Matrix Eligibility for DepositGuarantee Detailed
Underlying Data
Slide 52
Format of the Report Decision-making tools Graphic
representations Indicators & Icons Comfort level
categories
The Report Itself Summary Results Identity Verification
Personal Information Financial Profile Analysis Clear, concise
explanations 11 Pages in total
Slide 56
The Report Itself Detailed Analysis & Commentary
Slide 57
The Report Itself Detailed Analysis & Commentary
Slide 58
The Report Itself Immediate DepositGuarantee Elgibility Results
& Extra Benefit
Slide 59
Compuscan Partnership 1 of the big 4 Credit Bureaux in SA In
operation since 1994 20 million credit records 150 million accounts
Credit data provider Source data included
Slide 60
Availability & Cost?
Slide 61
A Final Word: The Importance of Consent Protection of Personal
Information Act (POPI): Covers information relating to clients,
suppliers, employees, persons receiving marketing information,
persons present on premises etc. All personal information which is
protected incl.: race, gender, sex, marital status, sexual
orientation, age, physical/mental health, religion, criminal and
financial records. Sources of information impacted include payroll
data, CVs, employment applications, HR & security records,
standard information, even internal emails. Existing manuals
created in terms of the Promotion of Access to Information Act
which spell out the companys policy must be updated in line with
PoPI. Explicit permission needs to be given for collection and use
before data is collected. Data can only be collected from public
domain; no more rented database lists Companies will also need to
motivate why they need to keep certain data. Individuals need to be
informed for how long information will be kept. (Institute of
Directors SA, 2014)
Slide 62
We hope that leaves you feeling more
Slide 63
Thank You! We welcome your feedback See you again in Q2 of
2015